VSE Corporation — Form 10-Q Summary
Business Context and Reporting Period
VSE Corporation provides sustainment, logistics, engineering, maintenance, supply-chain, information technology, energy, and consulting services primarily to the U.S. Department of Defense, U.S. Postal Service, and federal civilian agencies. The filing covers the three and six months ended June 30, 2014; financial statements are unaudited.
Operations are reported through Supply Chain Management, International, Federal, and IT, Energy and Management Consulting groups. The company had 5,355,698 common shares outstanding as of July 22, 2014.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | Six Months 2014 | Six Months 2013 |
|---|---|---|---|---|
| Total revenue | $108.0 million | $119.1 million | $227.4 million | $238.2 million |
| Operating income | $10.7 million | $12.7 million | $22.1 million | $22.6 million |
| Income from continuing operations | $5.9 million | $7.0 million | $12.2 million | $12.2 million |
| Net income | $5.7 million | $6.9 million | $11.3 million | $12.1 million |
| Diluted EPS | $1.06 | $1.28 | $2.11 | $2.27 |
| Operating margin | 9.9% | 10.7% | 9.7% | 9.5% |
| Cash flow from operations | Not separately provided | Not separately provided | $25.9 million | $24.2 million |
Operating margin is calculated from reported operating income and revenue. Contract costs were $96.5 million in Q2 and $204.1 million for the first six months. The six-month effective tax rate was 38.2%, compared with 37.5% in the prior-year period.
- Cash and cash equivalents were $302,000 at June 30, 2014, compared with $220,000 at December 31, 2013.
- Total assets were $363.2 million, compared with $380.5 million at year-end 2013.
- Total liabilities were $164.8 million, compared with $193.7 million at year-end 2013.
- Total stockholders’ equity was $198.4 million, compared with $186.8 million at year-end 2013.
- Total bank borrowings were approximately $67.4 million at June 30, 2014, down from $89.7 million at December 31, 2013. This included approximately $46.9 million of term debt and $20.5 million of revolving debt.
- The company had $125 million of revolving loan and letter-of-credit availability, with an option to increase availability to $175 million. No letters of credit were outstanding at June 30, 2014.
- The company declared dividends of $0.19 per share for the six months and paid approximately $963,000 in dividends. The loan agreement permits annual cash dividends of up to $0.60 per share, subject to compliance with its terms.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue declined 9%, while six-month revenue declined 5%, primarily because of lower activity in the International, Federal, and IT, Energy and Management Consulting groups.
- Second-quarter operating income declined 16%; six-month operating income declined 3%. Net income declined 17% for the quarter and 7% for the six months.
- Supply Chain Management revenue increased 15% in Q2 and 11% for the six months, driven mainly by growth in the USPS Managed Inventory Program. Segment operating income increased 10% in Q2 and 18% for the six months.
- International revenue decreased 26% in Q2 and 14% for the six months, principally following completion of the U.S. Treasury Seized Assets Program. Q2 operating income decreased 48%.
- Federal revenue decreased 14% in Q2 and 5% for the six months. Operating income decreased 65% in Q2 and 67% for the six months, primarily due to reduced U.S. Army Reserve vehicle-refurbishment work and lower margins under replacement task orders.
- IT, Energy and Management Consulting revenue decreased 18% in Q2 and 17% for the six months. Q2 operating income decreased 26%, although the six-month segment margin improved modestly because of cost reductions and operating efficiencies.
- Services revenue declined, while products revenue increased. Six-month services revenue was $144.4 million versus $161.8 million; products revenue was $83.0 million versus $76.4 million.
- Bookings decreased to $173 million from $248 million, and funded contract backlog decreased to $178 million from $238 million at June 30, 2013.
- Debt reduction lowered net interest expense by 26% in Q2 and 25% for the six months.
Cash Flow, Liquidity, Debt, and Other Financial Matters
- Six-month operating cash flow was $25.9 million, compared with $24.2 million in 2013. The increase was driven largely by collections of receivables, partially offset by inventory growth and reductions in accounts payable and accrued liabilities.
- Capital expenditures were $1.8 million, compared with $2.5 million in the prior-year period.
- Net cash used in financing activities was $24.0 million, principally reflecting $164.4 million of loan repayments, partly offset by $142.0 million of new borrowings.
- Scheduled term-loan payments after June 30, 2014 were $12.5 million in 2014 and $34.4 million in 2015. The loan agreement expires in June 2016.
- Actual debt and covenant ratios were within limits: Total Funded Debt/EBITDA was 1.17x versus a 2.50x maximum; Fixed Charge Coverage was 1.39x versus a 1.20x minimum; and Asset Coverage was 1.46x versus a 1.00x minimum.
- Interest-rate hedges covering part of the debt expired June 30, 2014. No borrowings were hedged after that date, increasing exposure to changes in variable interest rates.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management is responding to pressure in legacy government markets by expanding vehicle sustainment, logistics, and supply-chain capabilities into adjacent and commercial markets.
- The USPS Managed Inventory Program remains the largest revenue source and is primarily self-funded through USPS operating revenues rather than appropriated government spending.
- The Foreign Military Sales program has potential contract coverage of up to $1.5 billion over five years, but revenue timing depends on vessel-transfer legislation and foreign-government demand. Egyptian Navy support revenue was approximately $18 million in the first half of 2014; operations in Egypt remained affected by political unrest, although some workforce reinstatement began in March and April.
- The U.S. Army Reserve refurbishment program generated approximately $29 million of first-half revenue, but current task orders carry lower margins and future recompetes, extensions, and funding remain uncertain.
- The U.S. Treasury Executive Office for Asset Forfeiture program substantially ended in March 2014 after generating approximately $9 million of first-half revenue, compared with approximately $36 million in 2013.
- Discontinued ICRC construction-management operations generated a $279,000 Q2 loss and an $894,000 six-month loss, net of tax, related to claims on remaining bonded projects. Three projects totaling approximately $4.9 million of bonded exposure remained incomplete at June 30, 2014 and were expected to be completed in 2014.
- VSE is a primary defendant in Hawaii wrongful-death litigation related to a 2011 fireworks explosion. Management did not believe a material adverse effect was probable at the filing date.
- An Alaska lawsuit against subsidiary ICRC involves alleged breach of contract and negligence relating to a Port of Anchorage project. Because the case was at a preliminary stage, the potential impact could not be determined.
- The company recognized a $787,000 fair-value adjustment to the WBI earn-out obligation in the first six months. Total earn-out obligations were $9.8 million at June 30, 2014, including $1.5 million classified as current.
- FASB revenue-recognition standard ASU 2014-09 becomes effective for VSE on January 1, 2017; the company was assessing its impact.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether declining funded backlog and bookings indicate further revenue pressure, particularly in Federal, International, and civilian-agency programs.
- The sustainability and customer concentration risk of the USPS Managed Inventory Program, which represented approximately 35% of first-half revenue.
- The effect of lower-margin Army Reserve task orders and the timing of future recompetes or extensions.
- Exposure to variable interest rates following expiration of all interest-rate hedges and the company’s ability to meet scheduled debt repayments.
- The ultimate cost and timing of the ICRC bonded-project claims and disclosed litigation.
- The filing contains a numerical inconsistency requiring verification: the June 30, 2014 balance sheet reports net intangible assets of $77.175 million, while Note 7 reports $77.715 million.